When is cash no longer king?
When looking at investing our savings, the most obvious risk that comes to mind is the chance that the value of our money could fall. It can be a worrying thought. We work hard to build our savings and many of us are old enough to have lived through periods of uncertainty in financial markets. It has, quite understandably, made us aware of what could go wrong.
But the problem is, without taking an element of risk, we cannot expect a return. What many don’t know is that before making any investment, your advisor will bring you through a risk assessment. The first step is to talk it through. We can glean a lot of knowledge of past experience (both good and bad) in that initial chat. And your current circumstances may mean that paying down debt is a better solution than investing your savings. Everyone has a different set of circumstances and talking it through so your advisor understands is essential.
But then comes the science bit – you will be asked to complete a short questionnaire of multiple choice questions. The answers to these questions are then used to give you a number from 1 to 7 with 1 being ‘Lowest Risk’ and 7 being ‘Highest risk’. This is a European-wide scale that enables us to categorise investment risk tolerance on a sliding scale. We all feature somewhere on the scale, most often somewhere in the middle. This gives us a benchmark to work with as my idea of what ‘medium risk’ looks like and what someone else might think could be worlds apart.
Of course, it stands to reason that as we get older, a lot of us move down the risk scale a little. In many cases, we may have built up a nest-egg and we go into protection mode. We don’t have the time to make it back up if something were to happen to it. This highlights the importance of regularly checking in on our financial plans and making sure that it remains suitable.
So what kind of options are out there for a cautious investor? We meet a lot of people who have savings in the bank that are now looking to put their cash to work. Although we are in an age of rising interest rates, the banks are not yet passing these rates on to their depositors. But at least the money is risk free where it is right? Cash savings are categorised as ‘Lowest Risk’ on the risk scale, or numerically it’s a ‘1’. But the major pitfall in cash as an asset is its inability to keep up with inflation. This can be the single biggest risk our savings can face. Simply put, with inflation in Europe at a current rate of 10%, your savings will buy 10% less this time next year. With many bank deposit rates broadly at close to zero, this is a real and immediate risk to our savings. In order to guard against the impact of inflation, it is essential to look outside of bank deposits as a home for our savings.
But moving from the comfort of holding just cash in our portfolio to the world of investing needn’t be a big leap. The ‘sleep at night factor’ is paramount, meaning if my investment is causing sleepless nights, then it’s simply not the right investment for me. We should be comfortable in the risk we have taken on and the decisions we have made. For some, taking a small step in moving from a standard deposit account to a fixed term deposit account yielding 2%-3% per annum might be enough to start with. Or a step further might be to place your funds into a capital protected bond for 3-5 years. Again, these are available on the marketplace now. You are essentially guaranteeing your capital provided you commit to a certain term. And whilst your money is in there, depending on market performance, you have a fair chance of growing your money without taking any risk to capital.
A step up from this and you are in the world of investment funds. These come in all shapes and sizes, styles, estimated returns, protections, risks and degrees of volatility (ups and downs). What all these funds will have in common however is the investment risk scale from 1-7, our benchmark. The fund managers measure the risk involved in each fund and categorise it accordingly. This is a good starting point in narrowing down what may be right for you. The investment universe is vast and a good advisor will guide you through a selection of options that meet your circumstances. More often than not, a selection of funds can be the right answer.
Without taking on a lot of investment risk, you can transform your savings from cash earning little to no return, into a cautious portfolio or mix of investments that can begin to drive out returns of 3%-5% over time. Whilst taking the first step can be daunting for some, it is a step that is essential in safe-guarding the buying power of your money over time.
